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F106 Enterprise Risk Management '24 > 3. Risk taxonomy > Flashcards

3. Risk taxonomy Flashcards

1
Q

Risk concepts

A

Exposure
Volatility
Probability
Severity
Time horizon
Correlation
Capital

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2
Q

Exposure

A

Maximum loss that can be suffered from event

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3
Q

Volatility

A

Broadly measures variability within range of possible outcomes

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4
Q

Probability

A

Likelihood of an event

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5
Q

Severity

A

Loss likely to be expected from an event

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6
Q

Time horizon

A

Length of time exposed to risk OR time required to recover from / reverse effects of event

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7
Q

Correlation

A

Degree to which different risks behave similarly in response to common events

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8
Q

Capital

A

Risk- money set aside to cover unexpected losses
Working- money ser aside to support business strategy

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9
Q

What is risk taxonomy?

A

Full list, description and categorisating of risks faced by organisation

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10
Q

What are the 5 high level risk categories?

A

Market
Credit
Liquidity
Operational
Underwriting/insurance

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11
Q

Give a more detailed risk list

A
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12
Q

Define market risk

A
  • Risks arising from changes in investment market values or other correlated features e.g. interest rates and inflation
  • Incl. consequences of changes in asset values on liability values and asset liability matching
  • May refer to risk of changes in the market conditions e.g. lower sales / profit margins
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13
Q

What are the components of market risk

A

Trading risk
A/L mimatching
Liquidity risk
Repatriation risk

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14
Q

Economic risk definition

A

Risk arising from impact of macroeconomic factors on an org and/or customers

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15
Q

Examples of economic risk

A

o Aggegrate supply and demand
o Own and foreign govt policies
o (Un)employment levels
o Inflation, interest and FX rates
o Accommocation costs incl house prices

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16
Q

Interest rate risk definition

A
  • Arise from changes in interest rates incl.
    o Impact on consumer behaviour
    o Financial impact
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17
Q

FX risk definition

A
  • Arises from exposure to movement in FX rates
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18
Q

What do changes in FX affect?

A

o Transaction exposure- foreign revenues and costs as expressed in home currency
o Economic exposure- prices of exported goods&raquo_space; impact on foreign sales
o Translation exposure- consolidated accounts (think how FX affects results in segment reporting)

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19
Q

Basis risk definition

A
  • Arises from differences in the movements of two comparable indices
20
Q

Credit and counterparty risk

A
  • Credit- risk counterparty to agreement is unable or unwilling to make payments required under agreement.
  • Counterparty – Risk another party to transaction or agreements fails to perform contractual obligations, incl. performing them on time.
21
Q

What else might credit risk refer to?

A
  • May refer to risks relating to variations in credit spreads in the market
    o Caused by changes in asset values e.g. for a corp bond, due to actual or perceived change in creditworthiness of issuer
    o Sweeting considers it a market risk
    o Changes in creditworthiness may be informed by assessment of risk of not meeting contractual obligations (in terms of quantity, quality or timing) in part/in full due do inability/decision of issue
22
Q

Liquidity risk definition

A
  • Funding- risk money markets can’t supply funding to organisations when needed
  • Market - risk of insufficient market capacity to handle asset transactions at time when deal is required without sizeable change in price
23
Q

Insurance risk definition

A

Risk from deviations in timing, frequency and severity of insured events, relative to expectations that were held when underwriting or pricing

24
Q

Underwriting risk definition

A

risk of inappropriate selection and approval of insurance risk (component of insurance risk)

25
Q

What are some components of insurance risk?

A

Mortality
Morbidity
Property
Persistency
Expenses
Casualty risks
Underwriting risk

26
Q

Operational risk definition

A

Risk of losses due to inadequate / failed internal processes, people, systems or form external events.

27
Q

Components of operational risk

A
  • Processes
  • People
  • Systems
  • Events
  • Strategic risk
  • Crime risk
28
Q

Examples of risks in processes

A

 Efficiency vs effectiveness
 Errors
 Inadequate documentation
 Model and data risks

29
Q

Examples of risks caused by people

A

 Key positions unfilled
 Wrong people employed / promoted / retained
 Absenteeism
 Lack risk awareness
 Incompetence
 Dishonesty
 Agency risks
 Moral hazard risks
 Adverse selection

30
Q

Examples of system risks

A

 Out-of-date
 Insufficient access or capacity
 Unauthorised use / access to data
 Technological failure
 Inadequate back up systems / disaster plans
 Software errors

31
Q

Examples of risks brought about by events

A

 Business continuity
 Ineffective internal-change management
 Ineffective external-change management

32
Q

Example of strategic risks

A

 Inappropriate business strategy
 Inadequate business plans
 Changes in external environment
 Results not meeting s/h expectations
 Reputational risk

33
Q

Examples of crime risks

A

 People risk
 Technological / cyber risk
 Legal risk

34
Q

Environmental risk definition

A
  • Relates to natural environment and human interactions with the environment
  • Includes:
    o Natural disasters and climate change
    o Pollution
    o Impact of declining natural resources
35
Q

Legal risk definition

A
  • Arises from understanding of and adherence to legislation, incl. changes in accepted interpretation
36
Q

Causes of legal risk

A

o Breaching law e.g.
-Lack of awareness
-Lack of understanding
-Interpretation changes by law
-Deliberately
o Inability to demonstrate compliance with law

37
Q

What are 3 things that legal risks relate to?

A

o New legislation due to political or social pressures:
o Clauses, terms, or conditions in contracts
o Court judgements against org

38
Q

Political risk definition

A
  • Includes:
    o Risks related to political decisions and indecision
    o Changes in govt
    o Events related to political instability incl. terrorism and war
39
Q

Conduct risk definition

A
  • Risks relating to relationship between company and customers
40
Q

Examples of things that might affect conduct risk

A

o Operational failures- poor quality control and/or servicing
o Information asymmetry
o Keeping up with regulation and customer needs
o Market conditions
o Product development activities
o Strategic objectives

41
Q

Other risks

A
  • Regulatory
  • Agency
  • Reputational
  • Project
  • Strategic
  • Demographic (e.g. mortality rates)
  • Moral hazard
  • Social (e.g. population characteristics, e.g. age profile)
  • Pension
  • Residual risk
42
Q

Examples of systematic risk

A

o Market return
o Industry-specific risks (limited number of sectors so can’t diversify fully)
o Interest rates for pension liabilities

43
Q

Examples of non-systemic risk

A

o Non-systematic individual company return
o Components of insurance risk

44
Q

Concentration of risk definition

A

Risk of relying on success of one action without back up plan if fails

45
Q

Causes of concentration risk

A

o Inability to diversify and reduce risk
o Deliberate decision e.g. high expected returns in product/asset
o Poor risk management

46
Q

Contagion risk definition

A
  • Might be called “systemic risk”
  • When financial losses in a company or sector or country leads to losses in another
  • Exacerbated by media and way in which info is presented and spread
47
Q

Examples of contagion risk

A

o Financial infrastructure- Failure of commonly used system e.g. visa
o Funding liquidity risk- e.g. 2008 credit crunch
o Common market positions- where change in one share price leads to further changes
o Exposure to common counterparty- failure in one leads to failure in one // loss of confidence in sector
o Credit contagion- default of one org leads to financial difficulties for creditors and suppliers&raquo_space; more defaults etc
o Investors using the same flawed logic

F106 Enterprise Risk Management '24 (35 decks)

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